Purchasing a bullion-backed exchange-traded fund appears to be risk-free on the surface. An ETF (or ETN, Exchange-Traded Note) is a stock-like investment that tracks an index, sector, commodity, or other asset.
Gold ETFs are no exception. They keep track of the metal’s price, don’t demand you to keep any bullion on hand, and even publish the serial numbers of the bars they have on their website. Isn’t that appealing?
But, like the old joke about “waterfront” estate in Florida that turns out to be swampland, these items aren’t as simple as they appear when examined closely. Bullion ETFs, in practice, contain far more risk than most investors think. Furthermore, in the event of a catastrophic crisis, you may be required to have not only price exposure, but physical metal in your possession.
- Despite the fact that ETF shares tend to reflect the price of gold or silver, owning ETF shares has a number of drawbacks when compared to owning physical metal.
- ETF prospectuses are replete with loopholes and escape clauses that free the fund of duty in a variety of situations that could be harmful for your investments.
- The fact that you possess actual gold or silver rather than an unenforceable digital claim on gold or silver is the number one reason why owning physical metal is far superior to owning shares in an ETF.
This essay looks at the primary structural flaw that all bullion ETFs have, three specific risks you face with current ETF products, and why investors need a significant amount of real gold and silver in their possession.
The One Sentence Every Bank Customer Fears
Consider this scenario: You connect into your bank account to make a cash withdrawal, and you receive a message that reads:
- “At this time, we regret to notify investors that cash withdrawals are not permitted.”
The point is, this isn’t a work of fiction; it’s not a throwback to the Great Depression; and it didn’t take place in a third-world country. It happened in the United Kingdom in 2011.
M&G Investments, Aviva Investors, and Standard Life all temporarily barred investors from withdrawing assets 11 days after Britain voted to leave the EU (aka, Brexit) owing to “exceptional market conditions.”
In the United Kingdom, these are not modest, inconspicuous funds. Each is in charge of billions of pounds. However, due to the unexpected Brexit outcome, it became clear that prolonged redemptions would result in a liquidity crisis, forcing management to unload assets at fire-sale rates. Each fund’s executives believed they had no choice.
What does this mean in terms of gold-backed funds? Gold ETFs are subject to the same risks as other mutual funds. And all of these dangers revolve around two words…
Counterparty Risk
The definition of counterparty risk is that you rely on another party to make good on your investment. Your investment is in peril if they fail for any reason. Even a basic savings account relies on the bank’s ability to recognize your savings withdrawals at any time and in any amount.
The funds themselves were the counterparty for the UK investors. When they needed money from depositors, they were temporarily unable to return it (and consider that since it was a crisis at the time, it was precisely when customers needed access to that cash the most).
A counterparty risk exists in every bullion-backed ETF. When purchasing a gold ETF, you must consider a number of aspects, possibly more than you know…
Your investment could be jeopardized if any of these fail. Redeemation delays are possible, just as they were with the UK funds mentioned before. More crucially, given the types of crises Mike Maloney predicts, one or more of these counterparty risks will very certainly materialize with bullion ETFs. As you’ll see, several have already done so.
Every investor should be aware of three major counterparty risks associated with gold ETFs…
Risk #1: Emergency Liability
The problems of GLD (SPDR Gold Trust), the largest gold bullion fund on the market, have been well-documented. Many investors are unaware, however, that it poses significant counterparty risk.
The following statements can be found in the most recent fund prospectus (dated May 8, 2017):
- If the Trust’s gold bars are lost, damaged, stolen, or destroyed as a result of circumstances that make a person liable to the Trust, the responsible party may not have adequate financial resources to pay the Trust’s claim.
- If the Custodian becomes bankrupt, its assets may not be sufficient to pay the Trust or any Authorized Participant’s claim. Furthermore, in the case of the Custodian’s insolvency, locating the gold bars kept in the Trust’s assigned gold account may take time and cost money.
- The Custodian’s gold bullion custody operations are not subject to any specific governmental regulatory oversight.
- The Trust’s responsibility to reimburse the Marketing Agent and the Authorized Participants for certain liabilities if the Sponsor fails to indemnify them could be detrimental to a Shares investment.
Does any of this appear to be a sensible investment? Hardly. The danger is shifted to you in a push-comes-to-shove situation. The fund is structured in such a way that it can protect itself from the investor. Worse, if any of these things happen, the ETF may not even be able to monitor the price of gold.
That’s not all, though. GLD employs subcustodians to store some of their gold, which may surprise you. However, there are evident weaknesses in that relationship that could be disastrous. Take a look at some of the following quotes from the same prospectus:
- Under English law, neither the Trustee nor the Custodian may bring a breach of contract suit against a subcustodian for losses related to gold storage.
- The Trust may not be able to recover damages from the Custodian or the subcustodian if the Trust’s gold bars are lost or damaged while in their care.
- Because neither the Trustee nor the Custodian supervises or monitors the activities of subcustodians who may temporarily hold the Trust’s gold bars until they are transported to the Custodian’s London vault, failure by the subcustodians to exercise due care in the safekeeping of the Trust’s gold bars may result in a Trust loss.
- The Allocated Bullion Account Agreement requires the Custodian to use reasonable care in appointing its subcustodians, but the Custodian has no other obligations to the subcustodians it has chosen. These subcustodians may appoint other subcustodians, but the Custodian is not accountable for their selection. The Custodian makes no commitment to monitor subcustodians’ execution of their custody functions or their selection of additional subcustodians. The Trustee has no obligation to oversee any subcustodian’s performance.
- The Trustee may not have the right to inspect any subcustodian’s facilities, procedures, records, or creditworthiness in order to examine the Trust’s gold bars or any records maintained by the subcustodian, and no subcustodian will be obligated to cooperate in any review the Trustee may wish to conduct of such subcustodian’s facilities, procedures, records, or creditworthiness. The Trustee and Custodian’s power to take legal action against subcustodians may be limited, increasing the risk that the Trust would suffer a loss if a subcustodian fails to take reasonable care in the custody of the Trust’s gold bars.
So, to clarify, GLD’s custodian has subcustodians… and those subcustodians can have subcustodians… and all of these subcustodians can store gold without a written custody agreement… and GLD has no right to visit the storage facility… and the lack of documentation may affect the trust’s performance… and GLD has limited legal recourse?
This does not appear to be legal, let alone prudent. It’s evident that GLD is a disaster waiting to happen. This is a good example “The fund’s “chain of custody” is so badly designed that it leaves it exposed to a variety of disasters.
It only takes one provider to set the first domino in motion – “For example, “hey guys, we can’t get our hands on the gold we were holding in the fund” As a result, the fund might be crippled in an instant, forcing management to halt withdrawals. Investors would be unable to cash out their positions in this case.
Consider this: while the price of gold would rise as a result of this news, the fund’s price and your investment would collapse!
Risk #2: Administrative Oversights
Wait until you see this… If you already think GLD is risky, wait until you see this…
In 2016, Blackrock, the sponsor of the world’s second most popular gold ETF, IAU (iShares Gold Trust), acknowledged to failing to register new shares with the Securities and Exchange Commission (SEC). This is required of exchange traded commodity funds, however BlackRock reported that there was an issue “They had “administrative oversight” and sold shares that didn’t exist yet.
Although management claimed that IAU shares continued to trade without interruption, the truth is that the fund’s administrative control was lost. The SEC and state securities agencies both penalized them (not counting possible lawsuits from shareholders).
And, as is customary, the SEC, which is chronically overloaded and understaffed, completely missed it. As it turns out, “The “mistake” was only discovered after the fund notified the SEC. To put it another way, officials were completely unaware of the infringement!
IAU sold $296 million in unregistered shares in total. The concern for investors was that the fund’s price did not reflect the price of gold until those shares were registered. Consider logging into your account and discovering that the price of gold is rising while the price of your gold fund is declining. That is exactly what occurred to IAU stockholders for a short time.
At the time, management cited a surge in demand, but it was nothing more than what we’d seen many times before. What happens if (not if) gold demand rises once more? What if we experience a gold mania? What does this suggest about this management team’s ability to handle this and other crisis situations?
This error demonstrates that this fund’s management skills are poor. Managerial ability or lack thereof is a factor in all ETFs.
The majority of investors were utterly oblivious to this development. If a stampede for the exits had begun, nearly no one would have survived.
Risk #3: Relying on Banks
HSBC is the largest bank in the United Kingdom. It also serves as GLD’s custodian, which means it purchases and holds gold for the fund.
Many GLD investors are unaware that HSBC has a long history of scandals, including predatory lending, tax evasion, and even charges that its lack of controls aided terrorist groups and drug traffickers. Their “record” is quite extensive…
- Argentina’s government brought criminal charges against the local subsidiary in March 2013 for assisting firms in evading taxes and laundering money.
- The US Justice Department advised the bank in April 2014 that it needed to do more to improve its anti-money laundering safeguards.
- The US Attorney for the Southern District of New York announced in July 2014 that HSBC would pay $10 million and admit to misconduct to settle civil fraud charges stemming from the bank’s failure to monitor reimbursement claims submitted to the federal government in connection with government-insured mortgage foreclosures.
- For manipulating the foreign exchange market, HSBC was fined $275 million by the then-CFTC and $343 million by the Financial Conduct Authority of the United Kingdom in November 2014.
- HSBC paid $12.5 million to settle SEC claims that it failed to register with the agency before offering cross-border trading and investment advising services to US clients in the same month.
- It was alleged in 2015 that HSBC assisted rich customers of its Swiss private banking branch in evading taxes.
- In February 2016, HSBC agreed to pay $470 million to resolve mortgage origination, servicing, and foreclosure issues.
- One HSBC executive and a former colleague were charged in July 2016 with conspiracy to conduct wire fraud in connection with foreign exchange manipulation.
- HSBC was fined $32.5 million in January 2017 after failing to comply with a 2011 judgment requiring the bank to alter its foreclosure policies.
- HSBC agreed to pay $765 million to settle charges that it concealed risks related with mortgage-backed securities in October 2018.
- The investigation into whether HSBC performed illicit transactions began in December 2018, when the CEO of Chinese telecom giant Huawei Technologies was detained for allegedly breaching US sanctions on Iran.
The response is an emphatic and unequivocal NO. HSBC, on the other hand, remains the cornerstone agency in charge of holding and supplying bullion for the GLD fund.
The problem is that most bullion ETFs keep their gold in a bank. And this is the more serious issue for investors:
- One of the reasons we hold gold is to insulate ourselves against the banking system, which most ETFs are a part of!
During an economic or monetary crisis, this link between bullion ETFs and the banking system puts your investment at danger. Bullion ETFs are susceptible to a variety of restrictions, including emergency rules and bank closures.
What About Taxes?
If you didn’t know, the United States still has an antiquated gold tax legislation on the books. Gold is essentially taxed as a commodity “collectible,” which is currently 28 percent for most investors.
Because gold is the only asset held by bullion ETFs, the tax rate is the same. Physical-backed ETFs constituted as grantor trusts, such as the popular GLD, are classified into three groups. Generally, these ETFs are taxed as collectibles. The second type of collection is closed-end funds, which include both trusts and mutual funds. Finally, there are securities “Mining stocks, mutual funds, mining ETFs, and Exchange Traded Notes are all “linked to” precious metals. In most cases, these are taxed as securities.
In other words, there is now no tax benefit to purchasing a gold ETF rather than gold itself. You can learn a lot more about taxes by clicking here. Consider starting a Precious Metals IRA if you’re interested in tax-advantaged precious metals.
The #1 Reason to Hold PHYSICAL Gold
When an investor, you don’t want to have to wait for your bullion ETF to sell or for the proceeds to be paid out… or to discover that the fund doesn’t have the gold it believed it did… or to see your fund fall as the gold price rises.
You may be subject to limits in a crisis that range from inconvenient to disastrous:
- A power outage, no internet access, or a security compromise are all possibilities.
- Depositor funds are frozen and utilized to keep the bank viable in a bank bail-in (this has already occurred in Greece).
Physical gold will provide you with a quick form of money to cover any financial need or emergency if any of these or other events occur. You can’t accomplish these things with a gold ETF since most of them don’t allow regular investors to receive bullion (and the few that do are costly and slow). You’ll also have to wait for settlement, then for a check or funds to be transferred, all of which requires that the system is still working properly and that your request can be processed exactly when you need it. And those funds will inevitably find up in the financial system, creating yet another barrier to entry. And all the while, you were only “renting” a paper commodity that gave you little to no chance of receiving real gold.
So, the main reason to acquire physical metal rather than a paper commodity is that the nature of a crisis may require it, at least temporarily. You’ll need more than simply price exposure to get through a crisis: you’ll need gold in your possession.
Is Your Gold Investment a True Safe Haven?
Bullion ETFs are a lovely concept, but the risks are real and present. Worse, the reason you own gold is to insulate yourself against financial and economic instability and if you own a paper form of gold that comes with all kinds of counterparty dangers, you could lose that advantage.
Yes, owning actual gold entails some risk. Gold Eagles and other popular bullion coins, on the other hand, are a tangible asset with virtually no counterparty risk.
Physical gold is the most crisis-proof asset you can have in your possession.
Any form of crisis might put gold ETFs under increasing strain, rendering them unable to provide protection against the exact catastrophes that they are designed to shield us against.
Is it wise to invest in silver ETFs?
Silver ETFs are a straightforward and cost-effective option to invest in the metal. You may accumulate silver in smaller amounts over time with an ETF and avoid the headache of organizing or paying for secure storage. If there are sufficient trading volumes, liquidating your silver ETF units can be simple. This is something to keep an eye on, as it is with any ETF.
Should you take silver exposure now that ETFs are making it easier to invest in the metal? Here are a few things to think about.
Is there any silver backing for SLV?
The Silver Trust is managed by iShares, a BlackRock affiliate (SLV). SLV is the oldest ETF incorporating real silver, having been founded in 2006. It has a daily trading volume of more than 11 million shares and is backed by real silver kept in New York and London by a third party. With an annual cost ratio of 0.50 percent of net asset value, SLV is a passively managed fund. One ounce of silver is represented by each unit. Units can be exchanged for actual silver in baskets containing at least 50,000 units. Investors with smaller baskets will have to wait until their redemption orders are pooled with others to satisfy the 50,000-unit requirement, exposing them to price fluctuations.
Are metal ETFs a safe investment?
There’s no denying that gold and precious metals garner the most attention when it comes to metals. That is true for the typical person on the street, and it is also true for the average investor. When market volatility spikes, investors rush to gold exchange-traded funds (ETFs) and precious metals ETFs as relatively secure investments. That isn’t to say that investors should ignore the “other” metal ETFs.
Base metals and industrial metals are critical commodities in industries like building and technology, and they should not be overlooked. Metal ETFs should be part of your investment strategy if you want to diversify your portfolio or take advantage of a recognized opportunity in metal commodities.
Are exchange-traded funds (ETFs) terrible investments?
While ETFs have a lot of advantages, their low cost and wide range of investing possibilities might cause investors to make poor judgments. Furthermore, not all ETFs are created equal. Investors may be surprised by management fees, execution charges, and tracking disparities.
Are exchange-traded funds (ETFs) safer than stocks?
The gap between a stock and an ETF is comparable to that between a can of soup and an entire supermarket. When you buy a stock, you’re putting your money into a particular firm, such as Apple. When a firm does well, the stock price rises, and the value of your investment rises as well. When is it going to go down? Yipes! When you purchase an ETF (Exchange-Traded Fund), you are purchasing a collection of different stocks (or bonds, etc.). But, more importantly, an ETF is similar to investing in the entire market rather than picking specific “winners” and “losers.”
ETFs, which are the cornerstone of the successful passive investment method, have a few advantages. One advantage is that they can be bought and sold like stocks. Another advantage is that they are less risky than purchasing individual equities. It’s possible that one company’s fortunes can deteriorate, but it’s less likely that the worth of a group of companies will be as variable. It’s much safer to invest in a portfolio of several different types of ETFs, as you’ll still be investing in other areas of the market if one part of the market falls. ETFs also have lower fees than mutual funds and other actively traded products.
Is it a good time to invest in ETFs right now?
To summarize, if you’re wondering if now is a good time to buy stocks, gurus say the answer is clear, regardless of market conditions: Yes, as long as you aim to invest for the long run, start small with dollar-cost averaging, and invest in a diversified portfolio.
Is GLD ETF a safe investment?
Gold has been utilized in culture for thousands of years and is one of the most prevalent and valuable commodities on the planet. Gold was utilized as a form of currency in ancient civilizations, served as a symbol of success and wealth, and was a significant part of many people’s culture. For a long time, investors have regarded it as a reliable and secure investment.
There are several ways to invest in gold, including buying the real metal, buying shares in gold firms, buying gold futures, and investing in gold exchange-traded funds (ETFs). Some of these solutions are more expensive, while others are more difficult. Investing in gold ETFs is a low-cost and simple way to obtain exposure to gold, and the SPDR Gold Shares ETF (GLD) is one of many available.
The SPDR Gold Shares ETF (GLD) monitors the over-the-counter (OTC) price of gold bullion.
Does SLV deteriorate?
As time passes, the SLV (black line) increasingly diverges from the silver futures line. This is due to the SLV fund’s natural decay rate, which is caused by fees, expenses, and other factors.
Who is in charge of SLV?
The SLV trust has amassed almost 338,000,000 million ounces of silver bullion since its inception in late April 2006. Unlike the popular gold ETF GLD, silver spot price decreases since 2011 have not significantly affected the amount of silver bullion held by JPMorgan for SLV.